Oil And Gas Key Themes 2020

Key View: In 2020 we believe that the oil and gas industry will continue to see Brent prices pressured lower, averaging USD62 per barrel in 2020 as a result of increased non-OPEC supply and a weak recovery in demand. In addition, we see OPEC+’s abilities to manage the oil market increasingly tested as available policy options narrow. On the sustainability side we expect oil majors will continue to shift capital expenditure to alternative energy industries involved in the low carbon economy. New investments in power and the wider sustainability landscape will tie into efforts to reduce carbon emissions and present a more climate-friendly investment case.

In 2020 we expect to see supply-side dynamics replacing demand led concerns as the key driver of market sentiment. Markets will focus more heavily on near-term factors impacting the oil trade balance and we believe market participants will increasingly look to supply drivers as the global economy settles into a lower growth mode at 2.7% for 2020 GDP growth based on our forecasts. Increased production cuts from OPEC+ will hold more barrels off the market until at least the first quarter of 2020, which we expect will help keep a floor under price in the near term. Compliance to the new production cut targets will once again come into the spotlight. We see loose compliance historically from Iraq and Nigeria, who are key markets to watch going forward, as their participation will play a role in dictating the likelihood of a further extension. If compliance is not met by all markets the cuts may be reduced or revoked and the potential for maintaining cuts uncertain (see below OPEC+ Policy To Reach Its Limits).

Output from non-OPEC sources will be a key area of new supply growth in 2020. Production increases are expected to come from the US, Norway and Brazil with the US set to dominate as source of global output growth at nearly 1mn b/d out of our full global growth number of 1.2mn b/d. US shale production will continue to be an area of intense focus and if the recent decline in growth fails to continue as expected could surprise markets​​​​​​.​ The increase in crude supply will outweigh demand growth and we forecast Brent to average USD62/bbl for 2020, two dollars lower than 2019.

2020 Supply Growth Roars Higher Led By Non-OPEC Producers

Crude, NGPL & Other Liquids Production Gains By Country, b/d (2020)

Source: EIA, Fitch Solutions

Despite the greater role of supply side dynamics in oil market sentiment, unplanned outages will have less of a role to play in price support. Spare capacity from OPEC, now even greater due to the additional voluntary cuts agreed in December, will likely mute the price impact of unplanned outages and geopolitical risk flashpoints. We see rising risks for outages in Libya as the current stalemate risks the escalation in attacks to control oil revenues as well as civil unrest Iraq potentially impacting security and the tenuous political balance. However, the impacts from any supply disruption would need to be sustained and longer-term given the expectation that markets will remain oversupplied even if OPEC+ production cuts remain in place for the full year.

Supply Outages Risk Remains Low

OPEC Spare Capacity By Month, mn b/d

Source: Bloomberg, Fitch Solutions

Oil Demand Recovery To Disappoint

Our demand growth forecasts sit significantly below consensus for 2020. Key forecasting agencies (see chart below) place growth in the range of 1.1-1.2mn b/d, almost 50.0% higher than the 660,00b/d that our data suggest. As such, we believe market expectations for demand will be largely disappointed in 2020. The relatively lacklustre uptick in growth we forecast next year rests on several assumptions. In 2019, oil demand has faced headwinds from both the top down and bottom up. Top down, the biggest drag on growth has been the deceleration in economic activity and, relatedly, the US-China trade war. Our economists expect that economic and trade growth will broadly stabilise next year, which should put a floor under demand, but which offers little upside. President Trump’s ratification of the Hong Kong Human Rights and Democracy Act has also materially damaged prospects for the signing of a phase one trade deal with China, posing downside risks to this view.

Demand Struggling Higher

Global - Oil Demand Growth Forecasts, '000b/d (2020)

Source: IEA, OPEC, Fitch Solutions

A number of major consumer markets have also faced localised drags on growth in 2019, including US sanctions, popular protests, subsidy reforms and other political and regulatory changes. On balance, our country level analysts expect these drags to ease next year but we see no major rebound in markets. There also remains the risk that a number of these drags spill over into the coming quarters. This was aptly demonstrated by India’s ongoing economic woes, which recently triggered a 95,000b/d downward revision in our oil demand growth forecast for 2020.

OPEC+ Policy To Reach Its Limits

In 2020 the ability of OPEC+ to effectively manage the market will fade, as its available policy options become increasingly exhausted. Beginning January 1, OPEC+ have decided to deepen their production cuts to 1.7mn b/d, from 1.2mn b/d previously. In addition, Saudi Arabia has pledged to continue its over compliance with the deal, bringing the headline cut to 2.1mn b/d, up from the 1.6mn b/d being held out of the market as of November. While the cut is substantial on the surface, we see a number of signs that OPEC+ policy is reaching its limits.

A 0.5mn b/d cut falls far short of the 1.8mn b/d and 1.2mn b/d cutbacks coordinated by the group in 2017 and 2019 respectively, and the cuts have been left to expire in March, the shortest term of any of the deals agreed. In order to secure the agreement, it also appears Saudi Arabia has offered several ‘sweeteners’ to the other participants. Russia, whose producers have shown growing frustration with the constraints imposed on them under the successive cut deals, was awarded an exemption for its condensates output. This should bring the market into 100% compliance with the deal, without any additional cuts being made.

Saudi Arabia has committed to pare back on its own production by a further 167,000b/d, bringing the kingdom’s total to nearly 900,000b/d. Saudi Arabia will now be carrying over 40% of the group’s overall cut, despite representing less than 25% of its production. It is possible that the December push for deeper cuts was partly influenced by the Saudi Aramco listing and a desire by the new energy minister Prince Abdulaziz bin Salman to stamp his mark on the group, impetus that may have faded when the group next meets.

Crucially, we believe that the effectiveness of OPEC+ policy has begun to ebb. The 2017 cuts were the overriding driver of a.10% y-o-y increase in the price of Brent crude that year. This sits in stark contrast to 2019, when prices have fallen by around 8%, in the face of the OPEC+ production cut deal and sharp declines in output in Venezuela and Iran (under sanction by the US). Given our expectations for strong growth in non-OPEC supply in 2020, including the US, Norway, Brazil and Guyana, and a weak recovery in demand, we believe OPEC policy will prove insufficient to prevent further y-o-y declines in the price, with Brent averaging USD62.0/bbl next year, down from USD64.0/bbl in 2019.

Majors Accelerating Sustainable Investments

Through 2020 we expect major oil and gas companies to continue to grow their investments into the ‘green space’ as a proportion of their total capital expenditure. Investment into the low carbon economy, including, renewable energy generation capacity, low carbon transport, biofuel and carbon capture technology will grow as companies seek to diversify their value chains. Exposure to the power markets, in particular with a focus on gas-fired power capacity and renewable energy capacity chain is appealing to majors, specifically as electricity demand growth is set to outperform the wider energy demand bracket in the long term. Similarly, this kind of investment looks to alleviate industry concerns over the potential disruptive effect of electric vehicles to the traditional fuel demand segment as these companies look to offer their own EV charging solutions, whilst leveraging existing downstream retail infrastructure.

Corporate strategy within the oil and gas sector has come under increasing pressure both from consumers and shareholders to address existential risks to its long-term business model from climate change. Through 2019, unprecedented levels of political and social awareness surrounding climate change, pollution and the need to decarbonize has seen both consumers and investors demanding companies be more aggressive with regard to carbon emission reductions as well as with demonstrating greater motivation for future progress in terms of mitigating negative environmental impacts and assessing climate risks. As a consequence of the growing requirement of these companies to adapt their traditional corporate strategy, we expect diversification to pick-up through 2020.

Capex Spend Of Majors 2020

Through the last two years, while investment, rhetoric and strategy regarding the green space has grown, we caution that in relation to companies total capital expenditure in their traditional business model, capital committed to the space remains low. Of an estimated USD115bn committed to expenditure programmes in 2019 only around USD3.5bn is expected to be allocated towards the green space. Next year, we expect investments into the green space to grow their share as a proportion of total capex. We note that there will remain a notable divide between the European and North American majors, with North American companies more likely to be the laggards. Likewise, large state-owned oil and gas companies, particularly in Asia, Africa and the Middle East remain relatively inactive in the low carbon space.